Today, Judge Engelmayer dismissed with prejudice a putative securities class action filed against DraftKings, Inc., and denied Plaintiffs’ leave to replead. Plaintiffs’ Second Amended Complaint alleged that a company that DraftKings had acquired in the course of going public, SBTech (Global) Limited (“SBTech”), had secretly operated in “black-market” jurisdictions, thereby exposing DraftKings to regulatory and criminal risks. It further alleged that DraftKings made materially false and misleading statements about, and failed to disclose, SBTech’s violations of foreign law and their potential consequences.

Plaintiffs argued that DraftKings’s shares traded at artificially inflated prices until June 15, 2021, when a short seller, Hindenburg Research published a report that revealed SBTech’s ostensible operations in black market jurisdictions and the risks to which the merger with SBTech allegedly exposed DraftKings. That day, DraftKings’s shares fell 4.17%.

In dismissing the Second Amended Complaint, the Court focused on Plaintiffs’ reliance on the Hindenburg report without having verified the information contained in the report:

The SAC’s claims as to SBTech’s business practices are virtually entirely based on the Hindenburg Report, which in turn was largely based on unsourced or anonymously sourced allegations. The SAC’s threadbare sourcing and the conclusory quality of these factual allegations and attributions are ultimately fatal to all of its § 10(b) or § 20(a) claims, whether based on DraftKings’s statements about its compliance with law or its failure to disclose SBTech’s ostensible black-market activity and revenues.  

Judge Engelmayer found that the Hindenberg report had “two features that are problematic in compounding ways.” First, the report was authored by a short seller who had an economic interest in driving down the stock’s price. Judge Engelmayer cited cases holding that adverse factual allegations from short sellers “must be considered with caution.” Second, the report was based on unidentified and unspecified sources. Judge Engelmayer noted that while a confidential source need not be identified to have statements credited on a motion to dismiss, “such a source must be ‘described in the complaint with sufficient particularity to support the probability that a person in the position occupied by the source would possess the information alleged.’” (citing Emps.’ Ret. Sys. of Gov’t of the V.I. v. Blanford, 794 F.3d 297, 305 (2d Cir. 2015)).

Judge Engelmayer noted that where independent facts corroborate anonymous sources, courts will sustain complaints. He contrasted that with what Plaintiffs had put forward in their Second Amended Complaint:

But when plaintiffs’ counsel has not interacted with the unidentified source—and does not even know the source’s name, position, or other attributes tending to bear on the source’s credibility—and instead extracted and pled as true statements from a report by a short seller attributing adverse facts to unidentified persons, these aspects of the complaint, if not corroborated, are fairly discounted or put aside altogether as ill-pled.

Other SDNY judges have expressed similar wariness about relying on unknown or confidential sources as the basis for complaints, see our coverage here, here, and here.